I’m so confused here. Q: Which of the following would generally suggest a narrower tolerance band? a. Assets in the portfolio tend to be illiquid b. Highly volatile assets c. Correlated portfolio assets I went with C, thinking that you could have a tighter band with correlated assets because even when they change in value, the proportions will remain about the same and reducing need to rebalance. Also, I thought highly volatile assets need a wider band since their value is constantly changing by large amounts, so a narrow band would cause constant/expensive rebalancing. I understand Schweser’s explanation with regard to the illiquid assets, but then they got vague. Am I missing something? Thanks!
it should be B. the more volatile the asset class, the narrower the band to prevent it from drifting too quickly out of tolerance limit. other 2 would suggest a wider band.
The volatility one is contrary to what you think. I agree that you would think that higher volatility requires a wider band, but it just ain’t so. Just burn it into your brain. B is correct.
Highly volatile assets => greater chance of a further large move away from target. => narrower tolerance band Correlated portfolio assets => lower chance of large move away from target. (because high correlation implies asset value move together with portfolio value). => wider tolerance band